Bonds: Weapons of Mass Capital Destruction

PHOTO: Too many investors may be destroying rather than building value when it comes to bonds.

Despite the go-go stock market of the past year, a lot of money is still flowing into bonds, much of it from investors burned by the stock market meltdown of 2008.

Yet, as yields of good credit-quality corporate bonds are running about 3 percent, this just isn't a good way to make money. While nodding to these paltry rates, many investing experts nonetheless wax nostalgic over the glory years of bonds, starting in the 1980s and continuing into the 21st century. Back in the day, bonds were great, goes the logic, so they may be again. But few people in the industry are willing to recognize that, even during the glory years, bonds weren’t good enough to be better than stocks.

Sure, bonds can play a role of diversifying portfolios to the extent that their prices move in different directions than stocks’. But bond aficionados go further to claim that bonds help preserve capital, though just the opposite is true: They destroy it. So entrenched is the idea that bonds offer protection of investors’ capital that anyone who says otherwise is considered a heretic.

But history has shown that we should listen to and carefully consider those who advance unconventional views. In the mid-1800s, Ignaz Semmelweis, a Hungarian physician practicing in Vienna, was reviled for his view that maternity ward mortality rates were high because doctors were passing “morbid particles” to patients because they failed to wash their hand between procedures. (The existence of microbes had not yet been established.) The medical establishment, closed-minded by the misguided notion that gentlemen, especially doctors, couldn’t possibly pass along diseases, roundly condemned him. Semmelweis was ridiculed, deemed insane and committed to an asylum where he soon died after being beaten by guards.

He is now respected as a pioneer in hygiene. His name also lives on as an example of the folly of automatically rejecting beliefs simply because they run counter to established norms. Today, this automatic rejection of ideas just because they vary from what everybody “knows” is known as the Semmelweis reflex.

Reactions of the broad investment community to the suggestion that bonds aren’t good investments bring to mind the Semmelweis reflex. Such doubters should objectively consider facts of financial history pointing to the undeniable reality that bonds are weapons of mass capital destruction.

Bonds with high credit quality will always give you back the face-value capital you invested. The problem is that they destroy your purchasing power, meaning that this capital is worth less.

This was true even during the glory years. Let’s say that in 1984, instead of buying a Cadillac for $20,000, you put this money in a 30-year bond that paid 12 percent — what bonds were paying then. Today, at the end of the 30 years--and assuming the company that issued the bond was still in business--you would have received your $20,000 back, and along the way, you'd have collected $72,000. You'd have enough accumulated income to buy fully-loaded Cadillac, which now costs three times as much as it did in 1984.

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